Equity investments in the cannabis industry are at an all-time low, leaving operators to resort to private lenders for high-interest loans to fund operations. In 2021, cannabis companies racked up $1.65 billion in debt; in 2022, it skyrocketed to more than $5.62 billion of issued debt financing.
Alarms are now going off because these loans are maturing, and payments are coming due. This is troubling, because company valuations are decreasing, interest rates and inflation are rising, and there’s price compression, making it nearly impossible to refinance the debt.
Since bankruptcy is not an option, what is the solution?
Is the Bet on Corporate Bonds?
Passing the Safe Banking Act or some sort of reform would open the door for brokerage firms to underwrite corporate bonds and provide capital to cannabis companies. But many investors will continue to be cautious about participating in the cannabis industry until federal legalization materializes. Those willing to jump in could provide stability in the meantime.
For decades, regular businesses have used corporate bonds to fund and expand their businesses. America was built on bonds, and the cannabis sector can be too.
Public and private companies can access bond market underwriters through brokerage firms if they have assets such as real estate, equipment, or intellectual property to secure the bond.
But, first and foremost, you need financial hygiene. Your accounting must be in proper order to get any sort of financing.
Brokerage firms likely will not underwrite a bond for less than $50 million because of the cost and effort it takes for due diligence and SEC filings, leaving this option only for larger organizations. Not all companies can set aside vast amounts of money each year to cover their amortized debt.
As we all know, consolidation is coming, and bonds also offer companies the opportunity to leverage buyout-type structuring to make these acquisitions.
Aren’t Corporate Bonds Risky?
There is no guarantee of which is riskier: a stock investment or a bond investment. They both have variables that sway the results.
Suppose a company that has issued bonds collapses. In that case, the investor’s money potentially would be safer than as a stock investment because of its collateral-backed bond.
You can also add terms and nuances to the underwriting to protect and benefit the issuer and investor, such as call features, put features, and sinking funds. There are multiple ways to structure a bond to work in everyone’s favor.
As the industry matures and cannabis companies grow and the cash flows, they will become more financially capable of achieving an investment-grade rating and lowering their cost of funds.
Those who invest in stocks are looking for appreciation. With bonds, someone wants to collect their interest and investment at maturity.
Are Brokerage Firms on Board with Cannabis?
Large investment banking firms might participate before federal legalization, because they may be concerned about the potential collateral damage from prominent investors and clients who oppose cannabis.
However, there are brokerage firms in the space right now that will jump in and start underwriting bonds. If a company can save 10% on $100 million because they can get a better rate issuing a bond versus private debt financing, that’s a significant saving and adds up quickly.
It’s a win-win for both sides. Underwriters make substantial fees, and cannabis companies could have access to lower-cost financing.
Publicly offered and traded bonds also will attract other capital pools, such as individual investors, ETFs, mutual funds, and institutional money, to invest in the cannabis sector.
Terry Buffalo is the CEO and founder of Buffalo Cannabis Advisors. He has more than 30 years experience in investment/financial advising and seven years in the cannabis industry.
Pam Chmiel is the CMO for Studio 420 Creative Agency.